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Risks of internationalisation

Risk assessment

There are likely to be risks inherent in a foreign environment that are not present

at home. For example, there is political risk, that is, the risk concerned with dangers of

war and civil unrest, unexpected increases in taxes, restriction of remitting funds to

the UK and the seizing of the business’s foreign assets. Vodafone Group plcexplains

its own risk in its 2007 annual report:

The Group’s geographic expansion may increase exposure to unpredictable economic,

political and legal risks. Political, economic and legal systems in emerging markets his-

torically are less predictable than in countries with more developed institutional struc-

tures. As the Group increasingly enters into emerging markets, the value of the Group’s

investments may be adversely affected by political, economic and legal developments

which are beyond the Group’s control.

For any particular investment, these risks may be no more, or may even be less,

than those arising from investing in the home country. They are, however, additional

to those faced at home. One way to avoid political risk is simply to avoid investing

in those countries where the political risk is high. There are commercial services that

provide information on political risk, country by country. Another way of avoiding

political risk is to insure against it. It is quite common for businesses to insure their for-

eign investments.

15.5 Risks of internationalisation, management of those

risks and portfolio theory

International investment and risk reduction

As we saw in Chapter 7, it is probably better for businesses to concentrate on the most

profitable opportunities and to leave risk diversification to the shareholders at the

portfolio level. This is because shareholders can eliminate nearly all specific risk from

their portfolios by having a reasonably large number (15 to 20) of holdings of shares

in businesses across a range of industries. Logically, we can extend this principle to

diversifying into international securities. This is because risks that are systematic

within one country might be specific to that country and so can be eliminated by inter-

national diversification.

The evidence supports this assertion. Shapiro and Balbirer (2000) show that inter-

national portfolio diversification leads to a relationship between portfolio risk, on the

one hand, and the number of different holdings in the portfolio, on the other, as shown

in Figure 15.2.

This shows the standard deviation (a measure of risk) for portfolios of increasing

levels of diversification. We met this in Chapter 7. The risk of the portfolio decreases

significantly as the number of securities making up the portfolio is increased. This

decrease is significantly more pronounced when international securities are included

in the portfolio.

Cooper and Kaplanis (1995) showed that there is a relatively low degree of correla-

tion between the returns from equity investment in one country and those from

others. For example, in the period January 1991 to December 1994, the correlation

between the UK and Japanese equity markets was only 40 per cent (perfect positive

correlation =100 per cent). The correlation between the UK and the Netherlands was